Answer to Question #155839 in Microeconomics for Jack

Question

Question 1:

 

Mr Jones has a weekly income of $100 which he spends entirely on two goods, Coffee (C) and Biscuits (B). The price of Coffee is $1.25/jar and the price of biscuits is 50 cents/packet.

 

a)     Identify the weekly budget constraint faced by Mr Jones and calculate the slope of the weekly budget constraint. Draw a graph of Mr Jones budget line with the quantity of biscuits on the x-axis. Show your working.

b)    Draw an indifference curve consistent with Mr Jones maximising his well-being at a level of consumption of Biscuits of 50 packets per week.

c)     Reproduce your diagram and show the effect on Mr Jones’ budget constraint of an increase in the price of Biscuits from 50 cents/packet to 75 cents/packet.

Answer 1

a. When the weekly budget = $ 100

and the price of coffee per jar = $ 1.25

the price of Biscuits per packet= $ 0.5

Identified budget constrain will be as follows:

$100 = 1.25 C + 0.5 B

Or

C= 80- 0.4 B

The slope can be derived from the equation of a line in the form of

$y=mx+ c$

where m represents the slope

therefor slope = -0.4

b.

Maximizing well being is only possible when marginal utility is maximum and the the budget on coffee is zero. A provision of consumption of biscuits for 50 packets weekly represented marginal utility of

U= $50 \times 0.5$ = $25

Different indifference budget constraint will arise with a different slope as follows.

0= 80- m$\times 25$

m= 3.2

indifference budget constraint therefore shall be

C= 80-3.2B

C. an increase in the price of Biscuits from 50 cents/packet to 75 cents/packet changes the budget constraint and utility function to

$100= 1.25C + 0.75B

C= 80-0.6B